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Unbundling of finance 2.0

In my last post, I talked about how Banking is the next frontier for disruption. We read about the changes we have gone through in our lives in the last 10 years because of similar disruptions in other industries; and also why it is high-time to disrupt Banking. In this post, I will show you how this disruption is happening via the unbundling of Banks.

A post from Hedgethink gave me this picture that summarises the unbundling of Banks in USA and Europe. Although this lists only a handful of top players in each category. Once you dig deeper, there are almost 100+ startups disrupting all these categories.

Let’s take a look at some of these services that are being unbundled.

Everyday Banking – Everyday banking basically involves a checking/savings account to hold money, transfer to other accounts, pay bills, give standing orders for deductions, probably a card for swiping at vendors and a tracker of all the activities performed.

All these activities are presently being done by your Bank’s mobile app or website. And since this is the ‘only’ service we have at our ends, we believe all this is pretty fast and seamless. Just like people 10 years back believed that Blackberry phones were the best that ever could be. Until Steve Jobs showed them otherwise. Similarly, imagine using a service like Paytm v/s your bank’s app. Paytm has more ease, relevant tie-ups (for bill payment, etc.), easier peer-2-peer money transfer model, uploading money and deductions process, and on top of it the 7% interest doesn’t hurt either. Now how is Paytm able to give this kind of service and interest rates? The reason is that it is asset-light, low overhead and automated (no branches, less humans, less calls/sms and less checks involved). Banks can’t be the same. And this means no fees on ATM deductions, lower transfer fees and other service charges; plus better service and customer support. These are the reasons why today I keep a 50–60k balance on Paytm and almost nothing on my Savings account. Who needs Banks?

Wealth Management – This basically involves investments and savings. It is now common knowledge that you should keep 3 months of your present salary as an emergency fund in your savings account and invest the rest in a diversified portfolio (after taking an insurance obviously). Banks give several options for this – FD, RD, Mutual Funds, Index Funds, various ETFs, Bonds, etc.

All these activities are being managed by Relationship Managers from Banks (on Customer side) and Fund Managers (on Investment side). Obviously these things can be initiated via Online Banking or mobile app; however, the online interface only acts as a lead generator and ultimately everything happens offline. This offline model is not only cumbersome, but also results into higher fees charged by Banks. Startups like Betterment and Wealthfront give robo-advisory services, which means that based on your aspirations, your risk appetite and present financial stage, they automate the investment process via AI. That is, in simpler terms, these funds are not actively managed by humans. Every robo-advisory firm has a different algorithm and investment mindset, but the common thing is that they are able to give similar sort of results with much less fees and a simpler process. Besides, who wants to ‘think’ about finance. Just look at my data, do some magic, and automate my investments. Don’t ask me random questions and charge high fees.

Side Note: I am not an expert, but multiple articles on internet will tell you that the average returns on a Mutual Fund (actively managed, high fees, tries to beat the market) are always lower (usually 14% p.a. over a 10 year long horizon) than the Index fund (not managed actively, low fees, copies market movement), meaning that, even with all their expertise, very few Fund Managers are able to perform better than the Markets. In India, only 2–4 Fund Managers have consistently outperformed the Markets in the last 20 years. So much fuss about ‘expertise’.

International Money Transfer – This basically involves sending money by an individual from one country to someone in another country. This doesn’t work like normal Bank Transfers as the currency exchange ratios keep fluctuating, along with the economies of other countries. Western Union has traditionally been the market champion in this. WU charges around $5 for a transfer of $50 (10%) and upto $76 for a transfer of $900 or above (WTF!). This has been searched from Google. I take no responsibility on the accuracy, please sue Google.

Anyway, let’s take a look on the approach used by another startup, TransferWise.

Their Peer 2 Peer payments within a country idea is brilliant. For those who didn’t see the video, suppose A in India wants to pay INR 10 Lakhs to B in USA then rather than wiring the money, Transferwise finds a person C in USA who wants to wire $x to D in India. Then A pays D in India, and C pays B in USA. Imagine if there are 1000s of such transactions happening daily, it is easy to always find donors to match the amount. Huge cost savings for all parties involved. And they are able to pull this off with a much smaller team than Banks.

Peer 2 Peer Lending – This basically involves lending money to individuals or businesses through online services that match lenders directly with borrowers. In other words, it is giving individuals the power to invest in people and businesses directly, rather than keeping money in Banks and letting the Bank lend money further to the consumers and businesses.

Consumer lending is the most profitable business for Banks, and corporate lending is the most revenue generating. Banks in India usually takes deposits from individuals (or retail customers) at 4% p.a. via Savings Account or at 8–9% p.a. via Fixed Deposits or Recurring Deposits. They then lend this money to businesses and individuals at 9.25–20% p.a. The usual slab is that Corporate loans to very big corporate houses (think Ambani, Adani, Mallya, etc.) are given at 9–10%, and the rates go on increasing from then on for smaller businesses. For consumer loans, the lowest rate is Home Loans at 9–12% p.a. (because house itself is collateral and govt subsidies), then ‘New Car’ Loans at 9–12% p.a. (because Car dealers subsidize most interest rate from their own commissions, also car itself is a collateral), education loans at 9–12% (very selective loans outside top colleges, govt subsidy reduces rates), personal loans at 13–20% p.a. and then Credit Card loans (After the first 50 days are over) at 22–40% p.a.

Essentially, the margin between the interest rates they charge from borrowers and what they pay investors (people who deposit money in Banks), is their profit for taking the risks of giving out loans and their operating costs. Now here is an interesting quote by Marc Andressen that sums up my thoughts on these rates. ““We have a chance to rebuild the system. Financial transactions are just numbers; it’s just information. You shouldn’t need 100,000 people and prime Manhattan real estate and giant data centers full of mainframe computers from the 1970s to give you the ability to do an online payment.” Here is the link to the article where he talks about reinventing the entire thing (financial services as they are given today. To repeat myself, there is a huge opportunity for new age, low-cost, automated technologies to come in which can do creditworthiness analysis, fraud detection and much more with a team of 50, without 2500 branches across India. Plus they give the individuals a chance to directly invest in an asset class and earn some money. The money that they were owed till now by Banks. I will cover P2P separately in my next blog.

There are many other interesting developments happening in Fintech space, including Bitcoin, Bank as a OS, etc. but I feel these are more sophisticated things that can be dealt with later. But to summarise the whole thing, internet and mobile have totally changed the way we work, communicate, live and commute today. It is only fair that the way we bank also changes to match the new age. Millennials specially have very different expectations from digital services. These people will form the largest consumer base the world has ever seen in the next 5–10 years and they don’t have any legacy relationship with Banks the way our parents did. They are more open to try out new and different things, and as they mature, they will demand total control and transparency over their financial lives just the way they have it on other aspects of their lives. And any company that doesn’t respond to this demand will likely not stay in business for long.

~This post was the part 2 of a series. The writer of this post is the CEO at Trustio – a new age community lending platform for alumni-backed loans.